Risk of a Perfect Storm

Oil markets are heading into the period of maximum seasonal tightness (June through September) with relatively low levels of global crude stocks. With a forecast increase of 3 MMB/D in crude runs, we see extraordinary summer tightness in oil markets.

Price risks are asymmetrically biased to the upside. Oil markets are pricing in some geopolitical risks (Iran, Venezuela, Yemen, Saudi Arabia, Libya), but an actual loss could send prices a lot higher. We see OPEC cuts as perpetual while U.S. shale is facing tightness in pipeline takeaway capacity. U.S. shale producers are hedging less, pushing prices higher at lower non-commercial net length. For 2019, global supply outpaces demand by 0.9 MMB/D, eliminating 2018’s flow deficit and leaving stocks slightly up but still relatively low. Gasoline cracks to underperform versus last year but remain healthy, while distillate cracks will continue to increase year-on-year in 2018. Light product cracks soar in 2H19, as we approach 2020 due to global bunker spec changes. Watch for big changes in demand, price, and refinery yields due to the new IMO regulations.

A Warm April Does Little to Calm Markets as Storage Stocks Fail to Rebuild

Although it’s finally starting to feel more like summer in Europe, after a frigid end to Q1, it would be hard to gauge this from the gas market. While demand has fallen seasonally with above normal temperatures in April, supply issues remain, and with alarmingly low storage stocks injection demand cannot be delayed. Prices stay elevated, with this tightness in the prompt met by a rising commodity complex, seeing most European hubs out-turn above January-18 and Q4-17 averages in April. The curve shows strong backwardation on expectations of a normalization of storage stock levels and the potential for increasing LNG deliveries, but until this materializes it is difficult to see much downside. The other worrying feature is that this dynamic is driving record low seasonal spreads, and questions remain around how certain storages will be incentivized to fill before next winter unless something changes.

Challenge of Counter-Seasonal Buyers to Offset Seasonal Lulls as New Cargos Keep Up

Pure counter-seasonal buyers are losing their allure as a balancing force even as incremental supplies are being added in 2Q/3Q at historic levels. At the same time the emergence of China as a key global gas buying force will reduce the need for counter-seasonal buyers as year round buying grows for industrial uses. The JKM/ NBP/Brent relationship is moving towards one with a more pronounced seasonal profile, with the stronger linkages in the first and fourth quarters and weaker ones in periods of weak global demand.

As Hydro and Gas Stocks Build, Upside Risks for Power Prices, Especially in Winter

While EUA prices have been volatile this month, the carbon market continues to generally lend support to marginal costs. The recovery in hydro levels represents an important factor shaping up prices this spring, but bullish for power prices is the dire status of the gas stocks across Western, now at the lowest level of the past 5 years, with gas injections typically taking the priority relative to power generation in the next 2-3 months. Italy is the market that could be the most exposed this summer, given its known reliance on gas-fired generation, as power demand hits its maximum for the year, while power import capacity is set to be lower year-over-year in August and September. In addition to Italy, the French market is also vulnerable to higher prices in the context of lower gas stocks, more notably during the winter. The upside risks for France are the highest in 1Q-19, as we expect nuclear output to move closer to the low levels seen in 1Q 2017.

Margins Improve on Bullish Weather and Weak Gas Prices

Gas unit margins continued to rise in April as another sizable year-over-year drop in hydro output and gas price weakness boosted the call on gas-fired generation. With runoff down sharply, California accounted for a large share of the hydro reduction, but the Northwest also fell as below normal temperatures delayed snowmelt. Spot gas prices tumbled ~25% below prior year levels at U.S. hubs outside of California and averaged in the low $2 range at the Malin and SoCal border pricing points. Despite the seemingly attractive prices, Southwest merchant gas-fired capacity remains under-utilized with coal output approaching prior year levels in late March and April. Columbia River basin precipitation moved back above normal in April raising Apr-Sep runoff projections to 120% of normal. California precipitation was above normal for a second straight month and Apr-Jul runoff projections improved dramatically with the major river basins in the 80-100% of normal range. The region will get its first taste of summer-like weather next week. With maintenance outages ongoing, significant price gains are expected.

Coal Pricing Declines Pause in April, Fundamentals to Weaken

The seaborne coal market rebounded over April due to a combination of higher oil prices and stronger dry bulk freight rates. While China’s coal demand growth notably decelerated from the breakneck pace set in Jan/Feb, the nation’s import demand has remained strong. However, imports are expected to decline due to the addition of new port restrictions in areas of the country as well as strong growth in renewable electricity generation. With this outlook a bearish pricing outlook remains warranted.

Refined Product Imports into L. America Will Remain Strong Despite Recovering Mexican Crude Runs

Positive economic growth in 2018 continues to lift Latin American demand for transportation fuels. In 2Q18, S&P Global Platts expects gasoline demand to average 2730 MB/D, 10 MB/D higher year-over-year. Mexican gasoline sales in February remained strong, 20 MB/D higher year-over-year. Brazilian anhydrous demand continues to be vigorous amid weak pricing to the detriment of gasoline consumption. Latin American diesel demand is also forecast to grow near term. 2Q18 regional diesel demand is projected at 2775 MB/D, around 65 MB/D higher year-over-year. Brazilian diesel demand is gradually recovering, 2Q18 consumption is expected 30 MB/D higher year-over-year. On the supply side, Latin American refinery crude runs stay soft despite Mexican ongoing recovery (Madero, Minatitlan and Salina Cruz are ramping up). Estimated 1Q18 outages in the region were 700 MB/D higher year-over-year. However, Venezuelan runs have dipped further as the refining sector continues to deteriorate. 2Q18 Latin American runs are projected ~300 MB/D lower year-over-year. As a result of insufficient refined product output, Latin American gasoline and diesel imports are set to stay robust. 2Q18 gasoline imports into Lain America are expected 170 MB/D higher year-over-year while distillate imports are projected ~200 MB/D higher year-over-year.

February Stockpiles Draw by Less than the 5-Yr Average on Warm Weather

On April 24, the EIA reported end-February electric power sector coal stockpiles of 120.9 MMst, a draw of 2.6 MMst m/m as compared to a 3.7 MMst average February draw over the most recent five-year period (2013-2017). End-February stockpiles were sitting 37.5 MMst or 24% lower than the most recent five-year average and 25% below prior-year levels. As was the case last month, the key to the stockpile drawdown in February was lower production and fewer rail deliveries to plants.

Underneath Lumpy U.S. GDP Data, Positive Trends

During the first quarter, U.S. GDP expanded moderately. Consumer spending was weak, but this likely reflected data volatility. Business investment was solid, though spending on equipment was disappointing. Growth in exports and imports decelerated, but a rebound is expected in the next few months. The core PCE price index and the employment cost index both accelerated during the first quarter.

Propane Prices Rebound

Non-LST propane prices surged 13.7% higher last week. The sharp increase in propane prices is attributed to a confluence of Mount Belvieu fractionator outages and relatively low inventories. Propane/propylene inventories fell by 162,000 barrels during the week ended April 20, according to EIA data. Total stocks stand at 35.7 million barrels, which is 10% below year-ago levels and 26% below five-year-average levels. The EIA reported exports of 1.07 million b/d last week, the highest since early February, while implied demand fell to 884,000 b/d, which is in line with typical seasonal demand. With the propane forward curve in backwardation, producers are incentivized to export volumes as opposed to storing them at Mt. Belvieu. This market dynamic has taken much of the slack out of the propane market. Platts Analytics expects LPG exports to be 900,000 b/d for the week ending April 27. Steam cracker margins remain bearish. Rising ethane prices combined with declining ethylene prices have caused ethane cracker margins to sink to record lows, and the cracker margins for all other NGL feedstocks were in negative territory last week.

Ethanol Production Declines as Facilities in the Midwest Undergo Seasonal Maintenance

Manufacturing margins rise as ethanol and co-product DDGs gain. Discounts for blending ethanol in Chicago widen to a three-month high. RIN values decline. The 2018/2019 sugarcane harvest in the South-Central region of Brazil heats up. European ethanol prices tumble.

US Gas Weekly Report

Following yesterday’s 18 Bcf draw from storage, the year-over-year and five-year storage deficit now stand at 897 and 527 Bcf, respectively. Concerns over the storage deficits and forecasts calling for above-normal temperatures this summer may have sparked buying last week, with the NYMEX nearby continuation chart closing above $2.80/MMBtu for the first time since early February. The now prompt June contract also made gains this week, settling at $2.839/MMBtu yesterday —a level not reached since mid-March.

Nigerian Production Surprises to the Upside, Highlighting the Impact of Low Disruptions

Nigeria is a top-five LNG producer and has gotten off to its strongest start to the year in our records. The country has certainly not brought any new LNG trains online, but the cause for the start may be far simpler – low disruptions. Nigerian gas production is all associated, therefore any disruptions to oil can easily knock on to gas. Year-to-date, Nigerian oil production has run at high rates, with only some small production impacts in the first quarter, according to our oil service. In 1Q, disruptions amounted to 140kb/d, a 66% decrease year-over-year.

Cape Freight Rates Rally Sharply on Buoyant Sentiment

Despite escalations in trade protectionism from the U.S and China, capesize dry bulk freight rates have rebounded sharply in mid-April on more buoyant market sentiment. Chinese domestic iron ore production fell off sharply year-over-year in 1Q18 while steel production ticked up slightly, prompting stronger expectations of iron ore imports going forward. While we have marked up our freight rate assessments we remain somewhat bearish compared to the current FFA market.

FERC Order 841 Sets Foundations for Power Storage Growth, but States in Driver’s Seat

FERC’s final order 841 from February lays the groundwork for increased participation of electricity storage in wholesale power markets. Recently, the price of lithium batteries has seen a steep decrease driven by significant investments to fuel future electric vehicle growth. Storage can support stronger renewable penetration, and when combined with solar could disrupt the mid to longer outlook for natural gas power plants. However, the pace at which they will play a growing role in power also depends on their ability to get adequate value from the wholesale markets. FERC concluded that existing RTO/ISO wholesale market rules set unreasonable barriers for storage participation and finalized key principles for RTO/ISO to revise their tariffs to address these hurdles. While this new order should enable storage to provide new services in some markets, further actions from state regulators and other parties will be necessary to take full advantage of their technical specificities.

U.S. Commercial Stocks Build but Deficit Widens

Overall commercial inventories built just 1.4 million barrels last week as product inventory declines substantially moderated and crude oil stocks swung to a 2.2 million barrel build. Distillate inventories continued their relentless decline, falling another 2.6 million barrels to the lowest level in four years, with especially low stocks in PADD I and the Central Atlantic region, where colder than normal weather and increased exports have contributed to stock declines. Cushing crude inventories built 0.5 million barrels last week and are forecast to build another 1.7 million barrels this week but then should decline in May. Overall crude stocks build again this week some 500 MB/D as runs remain relatively low and imports elevated. Low runs and a rebound in light product demand lead to substantial stock draws of 1.5 to 1.8 million barrels each in the three major light products in next week's EIA data.

Financial Stresses Remain Low

This appears to be a week of consolidation and reassessment. The reflation trade peaked early in the week and then eased back slightly. The 10-yr treasury yield broke above 3%, and then settled back to 2.96%. Implied inflation was higher early in the week, and then fell back marginally. Commodities fell back about -0.5% on the week, but industrial metals fell -5.5%. The dollar was stronger. Oil was slightly softer, but oil volatility (OVX) lessened, as did equity volatility (VIX). The St. Louis financial stress indicator again fell back on the week, while overall stress levels remain low.

U.S. Ethanol Price Rally Continues as the Market Tightens Manufacturing margins rise as ethanol and co-product DDGs gain. Discounts for blending ethanol in Chicago widen to a three-month high. RIN values decline. The 2018/2019 sugarcane harvest in the South-Central region of Brazil heats up. European ethanol prices tumble.

Summer US Storage Build: How Much is Enough?

The pace of US storage refills for the balance of the summer is taking on increased importance due to the delayed start to the 2018 injection season, on top of below-normal inventories as of end-March. For May, Platts Analytics forecasts a 15.7 Bcf/d build, or ~110 Bcf/d week. While triple-digits weekly builds have historically signaled loose balances and thus considered bearish, this year such an injection pace likely will be needed to simply to reach 3.4 Tcf — a level that still would be upwards of 0.5 Tcf less than the past five-years end-October level.

Japan Product Demand and Product Stocks Decline

Runs moved lower by 161 MB/D, and crude imports also declined such that crude stocks built 1.11 MMBbls. Finished product stocks declined 0.17 MMBbls due to declines in gasoline, fuel oil, kero and jet. Gasoil had a large build. The pace of seasonal stock builds in finished products continued last week along with the seasonal decline in aggregate product demand. The implied refining margin again moved lower as cracks weakened. Implied marketing margins have been easing too. The overall downstream value chain has clearly been softer.

Global Equity Markets Have a Fairly Neutral Week

Global equities fell 0.4% on the week, while the U.S. was unchanged. Among the domestic tracking indices, retail and utilities performed the best and gained 3-4%. Industrials and materials declined 2-3%, and lagged in performance. Internationally, China and emerging Asia outperformed by gaining 0.3-0.6%.

Saudi Arabia: Latest FX Reserves Rise as Expected, Further Increases Likely

Saudi Arabia just reported their end-March foreign exchange reserves. Reserves increased $6.1 billion on the month and reversed the average $4.6 billion draw seen in Jan-Feb. Further increases in fx reserves are expected for April with a highly successful $11 billion bond issuance that was completed in the first part of April and domestic interest rates that are now market responsive to changes seen in USD-Libor rates. The IMF recently updated their fiscal profile for the Kingdom as part of their World Economic Outlook/Forecast. It shows a continuing fiscal deficit through 2023, despite a higher oil price assumption vs. their October outlook.

U.S. February 2018 DOE Monthly Revisions: Demand and Stocks

EIA just released their monthly February 2018 (PSM) U.S. oil supply/demand data. February 2018 demand came in at 19.62 MMB/D, which was a year-on-year gain of 431 MB/D or 2.2%, slower than the 1,227 MB/D (6.4%) gain posted in Jan. Demand was 465 MB/D lower than Platts Analytics had assumed, while the final demand figure was revised lower by 678 MB/D from the weeklies. Kero-jet demand grew 74 MB/D (4.9%) vs. year-ago and outperformed the average barrel growth rate of 2.2%. Resid and “other” also outperformed, with “other” gaining 459 MB/D or 10.2%. Much of that gain is in natural gas liquids demand, which is downstream feed for petrochemical plants. Final end-February total commercial stocks stood at 1,210.1 MMBbls, which were 0.5 MMBbls higher than Platts Analytics had assumed. Compared to February 2017 PSM data, total commercial stocks are now lower than year-ago by -144.4 MMBbls vs. -142 MMBbls seen at end-January. Crude stocks are -100 MMBbls below year-ago at end-February, compared to being -84.6 MMBbls lower at end-January.

The information above is part of PIRA Energy Group's weekly Energy Market Recap - which alerts readers to PIRA’s current analysis of energy markets around the world as well as the key economic and political factors driving those markets. To read PIRA’s Market Recap first, subscribe to PIRA Perspectives here.